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Do ETFs Drive Up The Cost Of Commodities?

For students of the investment markets, commodities are a fascinating subject. When the price of gold rockets to $1,900 per troy ounce, politicians and consumers don't start the blame game and anybody holding the precious yellow metal rejoices.

When oil rises, something entirely different happens. There's a collective mission to right the wrong. One report estimates that speculation in the energy markets may account for as much as $600 per year in extra energy costs for the average household. "Consumers are being robbed of their hard earned dollars," say the politicians, and attention is instantly turned to the speculators of the market. Are speculators controlling the price of commodities and could they be using exchange-traded funds to do it?

What Exactly Is a Commodities Speculator?When farmers, drillers or other people dealing in physical assets like grains, oil, corn and orange juice produce a product, a lot of money is invested into its production. They feel better about producing the product if they know they have a buyer and a set price. Contracts that require the producer to deliver the product on a certain date, for a certain price, benefit both the buyer and seller because each party can forecast future earnings.

A speculator is somebody who neither produces nor purchases the commodity. In most cases, a speculator is a sophisticated investor who buys and sells these contracts before they require that the investor sell or take delivery of the actual asset. By purchasing a contract at one price and selling at a higher price, they can profit. Of course, some speculators do take delivery, but the often vilified speculator isn't holding thousands of barrels of oil in most cases.

You Might Be a SpeculatorBecause of the wildly expanding ETF market, there's a good chance that you are a commodities speculator. If you own the second largest ETF, the SPDR Gold Trust (GLD), the United States Natural Gas Fund (UNG) or the United States Oil Fund (USO), you're a commodities speculator. However, your relatively small investment in the commodities market isn't having an impact on the global markets, and in most cases the fund you own probably isn't moving the market as much as some believe.

In early 2012, the SPDR Gold Trust held over 41 million ounces of gold in a vault in London, but according to Jason Toussaint, principal executive officer of World Gold Trust Services, GLD and other Gold backed ETFs only represent 10% of the world gold demand and that small piece doesn't have a profound effect on the markets.

But What About Oil?Let's be honest. We're not worried about gold speculators because we expect jewelry to be expensive and we don't rely on gold to power our cars to get us to work. Oil is what we're concerned about. In 2008, when oil reached a high of $147 per barrel, the media was full of reports about speculators driving the price higher. Some reviews could find no direct evidence that speculators were to blame, but thanks to some leaked Wikileaks documents, there may be some evidence to support the claim.

When oil prices were heading higher in 2008, the Bush Administration asked Saudi oil ministers to bump up production of oil to combat the prices, but Saudi Oil Minister Ali al Naimi said that they were having trouble finding buyers for their oil at current levels. If oil prices are based solely on supply and demand and the Saudis said that there was plenty of supply, why were prices at record highs?

Some point to the fact that oil speculators account for 64% of all oil contracts traded on the markets and those contracts are in the hands of a small amount of players. Goldman Sachs estimates that when contracts representing one million barrels are opened, the price rises by 10 cents.

The United States Oil ETF holds contracts representing 13.5 million barrels of oil, a small percentage of the total traded contracts, but as more ETFs enter the market, experts believe that these popular investment products will have a much larger effect on the price of commodities.

The Bottom Line As oil prices rise above the $100 mark, politicians and consumers renew their cries to rein in speculators. Although exchange-traded funds are one of the fastest growing products in the investment markets, and many blame the rising price and volatility of commodities on ETFs, it still remains exceedingly difficult to separate the speculators from the physical producers and buyers. For now, all we're left with is a Wikileaks document.